Oh Won’t You Stay…Until the Bonus is Paid

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by Brenda Berg

A new interpretation by the Colorado Department of Labor and Employment (CDLE) could have significant tax impacts under Internal Revenue Code Section 409A (409A). Many bonus and incentive programs require that the intended recipient remain employed with the employer through the date of payment. If the employee quits before the payment date, the employee is not entitled to receive the bonus. In fact, many bonuses are granted specifically in order to retain the employee.

In Interpretative Notice and Formal Opinion (INFO) #17, the CDLE interprets the Colorado Wage Act as prohibiting an employer from requiring the employee be employed on a certain date in order to receive a bonus, if all other conditions to receive the bonus have been met. See my colleague’s article here for more discussion about the new guidance in general.

If the CDLE interpretation is applied to retention bonuses, the bonuses might not, in fact, be forfeitable if the employee quits before the payment date. Since these bonuses are typically designed to be exempt from 409A tax rules under the “short term deferral” exception which requires there to be a “substantial risk of forfeiture,” this could mean that there is no longer a substantial risk of forfeiture. The amount could be considered deferred compensation that is subject to 409A – and all of 409A’s restrictions and an extra 20% tax for any violation. Earlier “vesting” and disregard of “substantial risk of forfeiture” could have other tax and accounting impacts as well, including the timing of federal/state income taxation and FICA taxation, and which taxable year is allocated the company deduction under the “all-events test” for liabilities. Read more

You Can’t Touch That: Permitting Cashouts of PTO May Create Tax Traps for Employees and Employers

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by Bret F. Busacker

As we approach year end, employers should give some thought to reviewing their PTO policies for the coming year. One of the most common tax traps that we see is employers offering employees the right to cash out their PTO.

“It’s their PTO, and if they have accumulated a large balance, then we want to encourage them to get the large PTO accrual off the books,” is a common explanation we hear from employers.

Not so fast. Giving an employee a choice between current cash and rolling over PTO hours accelerates the taxation of the employee’s PTO hours (even if the employee never elects to cash them out). Many employers are surprised to learn that an obscure IRS rule known as “constructive receipt” generally requires an employer to treat PTO as taxable wages at the earliest time the employee is able to elect to cash out the PTO. Read more

Surprise, Surprise, Come On Open Your Eyes and Check the Tax Boilerplate and Operating Agreements

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by John Ludlum

We have referenced Code Section 280G and the golden parachute rules recently on this blog, and we have also discussed LLC equity incentives.  It can be fun to see how these concepts play out in a practical way in executive agreements based on some recent experiences in negotiating terms for executives in connection with private equity acquisitions.

For Code Section 280G, there are basically 3 ways that Section 280G golden parachute terms appear in employment agreements:

  1. “Gross-ups” for 280G taxes (where the company makes the executive whole for any Code Section 280G taxes imposed),
  2. “Best-of” provisions (where the executive receives either the total amount of payments and pays the taxes or reduces payments to a level below the threshold where Code Section 280G taxes apply, whichever results in the greatest amount of benefits being paid to the executive), and
  3. “Haircuts” (where the total amount of Code Section 280G benefits are mandatorily reduced to a level below the threshold where Code Section 280G applies).

Read more

B-Side – Dual Status Issues with Partnership LTI

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By Kevin Selzer

Long term incentive plans offered by an entity that is taxed as a partnership present an additional problem compared to their corporate A-side counterparts.  If an employee is given an equity interest in the partnership, the individual will generally no longer be considered an employee for tax purposes.  Instead, that individual is considered a partner in a partnership, will receive a K-1 for future pay (rather than a W-2), must pay estimated taxes, becomes ineligible for certain benefits, etc.  This dual status issue is generally nonexistent within corporate entities – indeed, it is commonplace for employees to also be shareholders, perhaps as a result of a traditional restricted stock or option grant. Read more

In These Headlights Beams, Beyond My Wildest Dreams – An “Affiliated Group” for Section 280G?

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by John Ludlum

In these times of high M&A activity, we see a lot of questions about Code Section 280G (“Section 280G”) which we discussed generally on this blog a few weeks ago. One fine point issue that comes up relates to whether Section 280G applies in the first place.

Section 280G denies a deduction and imposes an additional 20% excise tax on “excess parachute payments” which are payments beyond a certain threshold that are made contingent on a change in ownership or effective control of a “corporation.” The definition of corporation includes all of the normal corporate entities, as well as publicly traded partnerships and foreign corporations, among others. But the Section 280G rules do not apply to partnerships or S-Corporations. Read more

The Music of the Night . . . Phantom Plans for Early Stage Companies

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By Kevin Selzer

Early stage companies that are strapped for cash often turn to long-term incentive compensation plans to attract and retain key employees and service providers. Many of these companies opt to put in place arrangements that grant actual equity interests (e.g., stock options or, in partnership-taxed entity, profits interests).  While these arrangements may be a good match for certain companies and situations, I find that phantom plans often fit better with early stage company/ownership goals. Read more

Free Fallin’…With a Golden Parachute

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by Benjamin Gibbons

For those who have been involved in the sale of a company, Section 280G of the Internal Revenue Code may sound familiar. Section 280G governs what the IRS considers to be “golden parachute payments” and is generally applicable when a corporation is undergoing a change in control (including both stock sales and asset sales). At a high level, Section 280G imposes on disqualified individuals a 20% excise tax on excess parachute payments paid and a corresponding loss of deduction on such payments by the corporation. Read more

Into the Distance, a Ribbon of Black, Stretched to the Point of No Turning Back? Understanding Your Biases in Making Tax Decisions

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by John Ludlum

In a former life, I studied how competent professionals made what turned out to be wrong and sometimes deadly decisions. Often under the general category of “loss of situational awareness,” we had sanitized terms like “target fixation” leading to CFIT or “controlled flight into terrain” (terrain impact caused by continued visual flight into IMC) or “instrument meteorological conditions” (how the mishap is described when a non-instrument rated pilot loses control after flying into clouds). We studied these mistakes to learn from them and to improve our own decision making. Read more

What About Now? – 83(b) Tax Rules Applicable to Early Exercise of Stock Options

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by Bret F. Busacker

Some years ago, I published an article on the importance of understanding the tax rules applicable to equity grants, with a particular focus on being aware of the timing rules for filing an 83(b) election and the importance of making timely elections (available here).

A reader of that 83(b) article approached me recently looking for guidance on when an individual may make an 83(b) election with respect to a stock option.  The question was simple – do you make the 83(b) election within 30 days of the grant of the option or within 30 days of exercise of the option? Read more

Romeo Finds a Streetlight, Steps Out of the Shade, and Says Something Like, LLC Compensation, How About It?

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Tips for Structuring LLC Incentives

by John Ludlum

On a frequent question of how to structure incentives for LLC entities, we find that many of our clients decide to use profits interests for only a few key employees (making them partners subject to partnership taxation) and a cash-based bonus plan for the majority of the employees. The issue of being treated as a partner involves receiving K-1 income, not W-2, so there is no withholding and the partners must deal with self-employment taxes, quarterly estimated taxes, and items like employer contributions to health plan premiums are taxable. But profits interests can receive capital gains treatment. Read more